Summary: Interest rates have long been dropping, making it unaffordable for all but the rich to live off interest income. Investors who are looking toward a future retirement, as well as those who help people plan for retirement, need to carefully consider how to adjust to today’s low-rate reality. Relying predominantly on bonds and other fixed-rate investments during retirement years may no longer work in many cases.
The traditional retirement planning approach has been to shift a person’s investments from growth to income as he or she moves from the accumulation years (growing the nest egg) to the distribution years (spending it down).
However, over a surprisingly long period of time, interest rates have continued to drop, and drop, and drop. Here’s a look at interest rates by decade since the 1980s (showing the average yield on the benchmark 10-year U.S. Treasury). Note that the decade of the 2010s is a partial decade, running through September 8, 2017.
Interest rates by decade
To put the above interest rates into perspective, let’s take a look at how much savings an investor would need to pile up, in order to provide $50,000 of annual income (using the above rates).
Balance required to produce $50,000 of annual income
See where I’m going with this? In order to produce $50,000 of income using the interest rates that were effective during the 1980s, one would need an invested balance of just under half a million dollars. That’s doable for a lot of folks. By contrast, today’s lower rates require a balance of more than two million dollars. For all but the wealthiest individuals, living off of income alone may not be practical given the dreadful rates now in effect.
Consider, in the 1980s, the face value of a bond was less than 10 times the income it produced. Today, a bond’s face value is nearly 50 times the income it produces. This means that it could take almost five times longer to save for retirement today than it did during the 1980s – five times! For a good many savers, a standard 40-45 year career simply will not provide enough time to save up the balance required to live off the interest.
Who knows the precise effects that lower interest rates will have. One thing is for certain, actions have consequences – not only in the physical universe, but also in finance. If low interest rates persist (or move lower), future generations will feel its impact.
Investors who are looking toward retirement, as well as those who help people plan for retirement, need to carefully consider how to adjust to today’s low-rate reality. The traditional approach of relying predominantly on bonds and other fixed-rate investments during retirement years may no longer work in many cases.